SWE2028 - Software Engineering

Economics

Accounting, Controlling, Cash flow

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Accounting
 It is part of finance.
 It allows people whose money is being used to
run an organization to know the results of their
investment:
 did they get the profit they were expecting?

 In “for-profit” organizations, this relates to the

tangible ROI (Return on Investment), while in
“not-for-profit” and governmental organizations
as well as “for-profit” organizations, it
translates into sustainably staying in business. 2
Contd…
 The primary role of accounting is to measure
the organization’s actual financial performance
and to communicate financial information
about a business entity to stakeholders, such
as shareholders, financial auditors, and
investors.
 Communication is generally in the form of
financial statements that show in money terms
the economic resources to be controlled.
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Contd…
 Itis important to select the right information
that is both relevant and reliable to the user.
 Information and its timing are partially
governed by risk management and governance
policies.
 Accounting systems are also a rich source of
historical data for estimating.

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 Accounting equation
The fundamental principle of accounting
introduces the relationship that exists between
the owner of a business and the business itself-
that of assets and equities.
 The fundamental equation is:
A=E
Assets = Equity Assets Equity

Assets are items of value that Equities are amounts that the
belong to a business eg. cash, business owes to the owner(s)
premises, trucks, stock etc.. and other people eg. capital,
mortgage, loan, creditors etc..
Accounting equation
 Equities are the claims on the assets of the
business. These claims fall into two distinct
categories:
1. External claims: the amount borrowed from other
people, known as liabilities (eg. Loan from bank)
2. Internal claims: the amount that the owner(s)
invest in the business, known as owner’s equity
(ie. The business borrows from the owner)
Therefore, the accounting equation can be
expressed as:

Assets = Liability + Owner’s Equity

A = L + O/E
A L + O/E
Accounting equation

Theaccounting equation may be

manipulated as:
A = L + O/E
Or L = A - O/E
O/E = A - L

The accounting equation forms

the basis of a balance sheet

A L + O/E
Historical Cost Concept
As well as recording in monetary form, accountants also record
the value of assets in their original price (when they are
purchased). This is known as the historical cost concept.

Note: Historical cost also includes any cost associated with

the purchase of the asset. Example: a business bought a
vehicle for $22 000 and paid $400 for a sign be fixed to the
vehicle and another $650 to modify the vehicle. It also paid
$680 for registration and $700 for a yearly insurance.
Insurance and
What is the historical cost of the vehicle? registration costs are
not included as these
are on going expenses
Historical cost = $22 000 +$400 + $650 that the business has
= $23 050 to pay.
Accounting equation
Example: xyz begins a business by investing
$7,000 of his own money. The accounting
equation would be:
Assets = Equity
Cash $7,000 = Owner’s investment

$7,000
If xyz then borrowed $5,000 from the bank to
provide the business with additional cash, the
accounting equation would be:
Assets = Liabilities + Owner’s Equity
Cash $12,000 = Loan $5,000 + Owner’s
investment $7,000
A L + O /E
Balance Sheet
• The assets of a business and the claims on
these assets may be expressed in the form of
a Balance Sheet. The balance sheet is a
general financial report. It consists of a list of
the assets owned by a business and a list of
people who have a claim on those assets at a
given date.
• A balance sheet is an important report that
an accountant draws up for the owner or
manager of a business.

L + O/E
A
 Further classification
• Assets and liabilities are further classified into
current and non current.
• Current assets are assets that can be liquidated
(converted into cash) within 12 months. Examples:
debtors, inventory, bank.
• Non current assets are assets that take longer than
12 months to be converted to cash. Examples: vehicles,
furniture, plant and equipment, investments, goodwill.
• Current liabilities are debts that must be repaid in
less than 12 months. Examples: bank overdraft,
creditors.
• Non current (deferred) liabilities are debts that
take longer than 12 months to repay. Examples:
Mortgage and other long term loans.
Controlling
 It is an element of finance and accounting.
 Controllinginvolves measuring and correcting
the performance of finance and accounting.
 Itensures that an organization’s objectives and
plans are accomplished.
 Controlling cost is a specialized branch of
controlling used to detect variances of actual
costs from planned costs.
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Five Activities of Controlling

– Measuring performance
– Comparing performance against
standards
– Identifying deviations from
standards
– Investigating causes of deviations
– Taking corrective action
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 Cash-Flow
 Cash flow refers to the money entering or leaving a project or
business during a specific period of time.
 When analyzing the economic feasibility of a project or
design, you will compare its cash flow with the cash flow of
other alternatives.
 The following table shows the cash flow for a simple 6-month
project. The project starts on January 1 with a small initial
investment and receives income in two installments.

Date Amount
Jan 1 - 1,500
March
+ 3,000
31 14

June 30 + 3,000
 Cash-Flow Diagram
 A cash flow diagram shows a visual representation of a
cash flow (receipts and disbursements).
 For instance, here is the cash flow diagram for the cash
flow described in the table on the previous slide.

$3,000 $3,000

1 2 3 4 5 6
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-$1,500
Cash-Flow Diagram—Details
 The horizontal axis represents time. It is divided
into equal time periods (days, months, years, etc.)
and stretches for the duration of the project.
 Cash inflows (income, withdraws, etc.) are
represented by upward pointing arrows.
 Cash outflows (expenses, deposits, etc.) are
represented by downward pointing arrows.
 Cash flows that occur within a time period (both
inflows and outflows), are added together and
represented with a single arrow at the end of the
period.
 When space allows, arrow lengths are drawn
proportional to the magnitude of the cash flow.
 Initial investments are show at time 0. 16
Cash-Flow Diagram - Questions

 How much money goes out?

 When does it go out?

 How much money comes in?

 When does it come in?

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Cash-Flow Diagram—Perspective
 Cash flow diagrams are always from some perspective.
 A transfer of money will be an inflow or outflow
depending on your perspective.
 Consider a borrower that takes out a loan for $5,000 at
6% interest. From the borrower’s perspective, the
amount borrowed is an inflow. From the lender’s
perspective, it is an outflow.
+$5,000 +$5,300

-$5,300 -$5,000
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Borrower’s Perspective Lender’s Perspective
Cash-Flow Diagram—Example

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